U.K. government should resist the VC trap

April 20, 2009

Margaret DoyleThe British government is considering whether to set up a mega public-private fund to invest in early-stage ventures. This would be a mistake. While British — and European — entrepreneurs have largely failed to produce huge successes like Google and eBay, bunging taxpayers’ money at the problem is not the answer.

In a policy document published on April 20, the government said it is evaluating whether to set up a public-private fund with similar objectives to the Industrial and Commercial Finance Corporation, the precursor to 3i. That was established with 10 million pounds in 1945 as Britain struggled to recover from war. Such a move has been urged on Lord Mandelson, the business secretary, by the Confederation of British Industry (CBI), the National Endowment for Science, Technology and the Arts (NESTA) and the British Venture Capital Association (BVCA). NESTA is looking for a 1 billion pounds fund; BVCA for 1 billion pounds-plus and the CBI for a round 1.5 billion pounds. The idea is for the government would lead the fund-raising by putting up an unspecified portion of the total pot.

Venture capital bigwigs speak of a calamity if the state does not step in. Britain risks “a lost generation of innovation”, says Simon Walker, the BVCA’s boss. NESTA warns that the country could lose 44 billion pounds in annual revenues unless it invests in growth businesses. Indeed, Walker believes the government shouldn’t waste time evaluating things and should simply start writing checks. Unless it does so, hundreds of early-stage businesses that need of capital may go to the wall. The BVCA recently published figures showing that investment in British venture capital collapsed by 62 percent from its peak in 2006, to 346 million pounds last year. Whether this had anything to do with the investment decisions that venture capitalists made in this period, BVCA didn’t say.

However, the industry’s argument that there is an “equity gap” that the government should fill is hokum. Returns to venture capital in Britain — and more broadly in Europe — have been dire.

The BVCA says that the median net internal rate of return between 1980 and 1997 (it would not give figures younger than 12 years old, though the returns turned negative over the tech bubble years) was 9 percent. This is a pretty mediocre given the riskiness of the sector. The picture across Europe is even worse. Data from Thomson Reuters and the European Venture Capital Association show an annual net internal rate return to investors of -1.1 percent (yes, minus 1.1 percent) from early-stage venture capital over twenty years to the end of 2008. Industry insiders say these numbers put European VC consistently at the bottom of the private equity heap.

Indeed, against this backdrop, it’s quite impressive that investors were willing to stump up 346 million pounds in British VC in 2008. Moreover, this number only looks low compared to the bubble years of 2006 and 2007.

Indeed one could even argue that, given the dismal returns, too much has been invested in European VC rather than too little. The problem may rather be cultural, or stem from excessive red tape. After all, European science if widely regarded to be up to that in America, but Europe has not turned that research into Google or an eBay yet (though Index, the darling of the sector, did a very good job flogging Skype to eBay).

There have been lots of reasons advanced for why U.S. VC has performed much better than Europe: the cluster of high-tech around Silicon Valley, a sophisticated and supportive venture capital industry, the bigger scale of the U.S. market or simply the American “can do” attitude. No one has claimed that it is because insufficient American taxpayers’ money has been put into venture capital. Mandelson should keep private equity’s hands out of taxpayers` pockets.

9 comments

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What is it with governments these days thinking that throwing money at a problem will solve it? There are ways to encourage venture capitalism and small business growth without handing out money — off the top of my head, tax incentives and legislated protections. Somehow, the world seems to have lost sight of the idea that the government and the economy are two separate entities.

Posted by Mike | Report as abusive

Well spoken. Indeed, there is a fine line between Venture Capital and Vulture Capital.

The Government should encourage the development of private sector commercial research centres. Such centres allow clustering of commercial research projects. The government should give grants to the centres based on the exports achieved by the manufacturers from the innovation developed in the CRCs. This could be limited to the taxes paid by the companies and staff. This makes the CRCs and manufacturers neutral regarding government taxes and revenue, but the flow on to the real economy is massive.
If the CRC is unsuccessful it folds and another group takes over. Successful CRCs may make video games, or even technology toys. Successful commercial products can be lawn mowers, like the Victa lawn mower in Australia.
I have written some papers on the subject if anyone is interested.

Regards,

Ted Roach
Roach Industries Pty Ltd
Sydney
Australia.

Posted by Ted Roach | Report as abusive

Absolutely. To dump taxpayer money into such a high risk, low return sector would be an act of madness. It is amazing that such well educated people can fall victim to such dubious statements from organizations like the BVCA

Posted by Silk Whisper | Report as abusive

I am 52 years old and I remember governments throwing money at problems 35 years ago. Nothing has changed or ever will until the present socio-economic system collapses and a new one is put in place. Joseph Stiglitz’s Nobel Peace Prize winning book showed conclusively markets are inherently inefficient for meeting demand in an economically sustainable manner. It is more like Vultures feeding on capital. Capitalism has replaced monarchs with Oligarchs. In my country many of these Oligarch’s relatives fill the seats of Congress.

Posted by Anubis | Report as abusive

You can’t have a capitalist system without venture capital. For the past three decades, financiers have used capital to create new financial products that created a river of money into which they dipped their buckets for personal profit.
Meanwhile, people with new ideas for new products that would have provided real jobs when the old (read existing) economy came to the end of its useful life have been starved of the resources needed to get going.
Only private enterprise will solve the current crisis, but the problems have been created by government policies, incompetence and inaction.
Now, only governments can remedy the defects of their own behavior.

Agree broadly with the thrust of the article. However there are some notable successes in early stage tech funding, particularly in the UK. All private sector of funds of course. A Government run/backed fund is unlikely to work. Their biggest problem would be deal flow which in turn is caused by a lack of backable management teams.If they really want to do that then why not invest in the private sector funds who have success to date?

Posted by David Notley | Report as abusive

This is a legitimate program if at least partially structured like a traditional fund where people have the opportunity to enjoy the benefits of their investment. There would be more oversight, an emphasis on ethics and longterm growth. None of those things are bad if we just reflect on recent events.

It’s been shown that throwing darts can frequently deliver better results than professional fund managers. Given the declines in the financial sector, it should be evident why darts tend to win. It’s because fund managers don’t have the foggiest idea what they are doing and therefore can be replaced by pointy flying objects.

On one hand we are telling governments to stop supporting industries that are in decline – like the auto sector. We should not tell them to stop experimenting with new industries. Because people precisely expect the government to help out. The expectation is there because the traditional free market approach has provent to be an abject failure necessitating enormous use of public bailout funding.

It is fine to have different ideologies and government administrations. All of that stuff comes and goes with the times. Bush really was a halfwit. Rumsfeld was a quarter of a wit. Brown at FEMA was an eighth of a wit possibly equivalent to a bright groundhog or prairie dog. These individuals will be recorded accordingly in history. Governments come and go. But we still have to look after individuals. Despite isolated failures society must continue no matter how difficult it gets. Britain has already been through the decline in its auto sector. They know what to expect and are preparing for challenging times.

Posted by Don | Report as abusive

There can be no denying the potential benefit of this type of scheme. The idea of government investing in business to drive the economy and the country forward is noble one. Unfortunately it is fundamentally flawed.

The rate of return on VC is poor and so this scheme risks being another black hole of the governments finances. While we all sit eagerly waiting to see what Alistair Darling is produce in the Budget it is widely expected to a sorry picture. Cuts in spending and eventually tax increases will be the only option to reduce the deficit. Spending money on a VC like scheme will simply increase the need for borrowing without providing any major returns.

Government run schemes inevitably involve a greater amount of red-tape and bureaucracy than the private sector so they will lack the dynamic attributes of true venture capitalists. It seems clear that VC has not performed very well for the world economy these days so how will the government be able to do it better when they will have a lot more box ticking to do?

Uncertain areas like VC need to be left to those know the area and want to live with the risks. It is not an area taxpayers should be involved with.

Posted by Andrew Tarry | Report as abusive

my government grants…

Your topic Boycott GM? Right Wing turns on “Government Motors.” | TheDetroitBureau.com was interesting when I found it on Monday searching for my government grants…